Tuesday, March 21, 2006

Why Deficits are Bad

First concept to wrap your heads around - Credit is limited commodity. There is a limited amount to go around.

Credit is excess capital people have that they are willing to loan to others.

Let's imagine a town. We'll call it Fictionville, USA. In Fictionville, there are only two people, Bryant and Person A. Bryant has all the money in the town, a grand total of $10.00. Hooray for Bryant! Poor Person A wants to catch the Ferry to Smashville (a happening place if ever there was one). So he goes to Bryant and asks for money to ride the ferry.

Briefly let's consider how much the ferry ride is. If it's say $0.05, well Bryant might just give that money away. On the other hand if a Ferry Ride is $9.42, Person A might have to do some real convincing to get Bryant to pony up the dough. Person A would probably have to promise some sort of return in order to convince Bryant to give up that much money.

As it turns out the ferry ride costs a fiver, and Bryant expects back $6.00 at some later point.

The next week, the population of Fictionville increases by 50%, i.e. one more person moves in. This person is known as Person B, and like Person A, she wants to take the ferry into town. Bryant can't afford to give them both the loan, so there is a scarcity of credit. So they compete. Person A says, "Hey, I'll give you 7 dollars on Tuesday if you give me $5.00 today." Person B says, "Hey I'm the only female in the story so far. What a gyp! But I will give you $9.00 on Tuesday if you give me $5.00 today." So as the two compete for the scarce credit, Bryant comes out ahead.

Oh the third week of our little storyline, Bryant's luck takes a turn for the worse. In moves Person C, who, as it turns out, also has $10.00. So now the credit is less scarce, and Bryant and that lousy Person C (why did I ever write him into my story?), have to compete. Immediately Bryant can't get 9 bucks on his 5 spot anymore (unless he goes around to Person C and convinces him to create an oligarchy to keep credit rates high (but let's face it, Bryant just isn't that smart)). Now rather than having the borrowers compete, it's the loaners that have to compete.

On the fourth week, Government Joe moves in. Government Joe needs a lot of money - $10.00 a week. He goes to Bryant and Person C and says "Hey look, give me a fiver apiece and I'll promise you 10 bucks each on Tuesday. What is the upshot of this? Person A and Person B can't go to Smashville anymore.

This is the Micro-Economic scale, but the basic principles are the same on a Macro Economic Scale. There is existing in the world right now a limited amount of possible credit. As Government Joe sucks up more of the possible Credit, the remaining credit becomes more scarce and more valuable. So when you go to buy a home or a car or a robot, you have to pay more in interest. That's simple capitalism. As something becomes more scarce, it becomes more valuable and more expensive. As credit becomes more scarce you have to pay more interest to get it.

That's bad for the economy and that's bad for the American people. Getting a house, getting a car, getting a robot becomes just that much more difficult.

As credit becomes more valuable, creditors start looking those they are loaning money to over more carefully. In particular they try to figure out the odds that individuals will be able to pay off their debts. A guy who has one house and lives within his means is a good credit risk. A guy who owns five houses and three boats and doesn't make nearly enough money to hold those holdings is not as good a credit risk. So if you have a limited amount of credit to spead around, who do you want to give credit too?

Could that problem ever apply to the US as a whole? I mean could we face a day when other nations and individuals determine that the United States is not a good credit risk? I don't know, but I don't think you can rule it out as a possibility.

And that's why, in my opinion, Deficits are bad.

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